Europe faces public health crisis and major economic shock

March 16th 2020 | Multiple countries | Disease trends

The spread of the novel coronavirus to Europe, which began in Italy in mid-February, and the subsequent ramping up of measures to contain the outbreak, means that the continent faces a public health crisis and a major economic shock this year.

This is no longer just a supply-side shock, with a limited impact on specific sectors—namely firms linked via supply chains to China or dependent on Chinese tourist spending—as might have been the case had the epidemic stayed confined to Asia.

The European economy now faces a sharp demand-side shock too as governments across the region impose unprecedented peacetime restrictions on citizens in an effort to delay the peak of the outbreak and thus protect their healthcare systems.

We are in the process of revising down sharply our forecasts for growth in 2020. They will reflect a 1.1% contraction in Italian real GDP, with growth of 0.3% in Germany, 0.5% in France and 0.6% in the UK. Our euro zone growth forecast will come down by 0.8 percentage points.

The spread of the coronavirus to Europe in February, and the measures taken to contain and delay it, have fundamentally altered the economic outlook for the region this year. We now expect real GDP growth in all of Europe to average 0.8% in 2020 (revised down from 1.6% previously), and growth in the euro zone to come to 0.4% (1.2% previously). These forecast revisions incorporate the impact of lost working hours, deferred consumer spending and investment decisions, business failures, and a reduction in trade and travel, as well as the governmental measures announced so far to offset these. They do not include a failure of the official response, owing to co-ordination breakdowns between countries or healthcare-system failures; a corporate debt crisis; or a breakdown in public trust in the government or of public order. However, these are downside risks.

Our current baseline scenario, on which this forecast is based, assumes that the virus cannot be contained within Europe, but that the social-distancing measures taken to delay the peak of the virus—at a stark economic cost—are effective, and healthcare services do not become overwhelmed. We assume that the virus will prove to be seasonal, receding over the summer but returning in the winter months. This means that the main hit to economic growth will come in the first and second quarters of this year, with a gradual recovery of consumer spending in the third. Governments will be better prepared for a resurgence of the virus in the fourth quarter, and by late 2021 we expect a vaccine to be ready for public use.

What has been the response to the crisis in Europe so far?

The European response to the pandemic has been notable for its tardiness and lack of co-ordination. The rate of increase of confirmed cases is following the same pattern in each country, with Italy in the lead, followed by Spain (seven days behind, according to data from John Hopkins University), France (nine days behind), Germany (11 days) and the UK (14 days). However, national governments are bringing a patchwork of different measures to bear on the crisis, rather than pursuing a co-ordinated approach. These range from a nationwide quarantine in Italy, with all non-essential commercial enterprises closed, to a simple request in the UK for those people with flu-like symptoms to stay at home. Among other measures, Germany has cancelled large public gatherings and is closing its borders; France has closed schools and universities, as well as cafés and restaurants; and Spain, Hungary, the Czech Republic and Slovakia have declared a state of emergency.

These different approaches are likely to prove less effective in containing the virus than a unified strategy. Efforts to co-ordinate the EU's response are being ramped up, with daily video calls between the bloc's health and interior ministries, but there are still inconsistent decisions being taken, for example over border closures and flight cancellations. National interests are not always in line with those of the region: for example, Germany and France have restricted the exporting of surgical face masks, despite a plea from Italy, which is facing shortages. China has stepped in, and is sending masks and medical experts to Italy.

Which sectors of the economy are most exposed?

Airlines, cruises and other travel sectors, as well as the hospitality, leisure and retail sectors, will be most under strain in the short term. Footfall on high streets will decrease as consumers shift towards shopping online—a trend that is likely to hold up even after the crisis wanes. Firms that are already struggling will be the first to fail (Flybe, a British regional airline that collapsed in early March, is an example). Small- and medium-sized enterprises (SMEs), which typically have less of a buffer against cashflow problems than larger firms, are likely to struggle to keep operating and to service their debt. More generally, there is a risk of a corporate credit crunch, with more than half of the debt held by European carmakers maturing by end-2021, according to Standard & Poor's, a rating agency. There are positive shocks for some sectors, too: producers of medical and cleaning supplies will experience a spike in demand, and as firms push their employees to work from home, information technology (IT) hardware sales will surge.

Governments across the region are moving swiftly to reassure firms, and workers, with spending pledges and tax holidays. France and Germany have expanded programmes that proved successful during the period after the 2008 global financial crisis, whereby employees can stop working temporarily and be paid by the state while retaining their jobs. The UK has promised emergency funding for the National Health Service (NHS), the European Commission will waive state-aid rules and the European Central Bank (ECB) has announced a substantial package to provide additional liquidity to the banking system. These measures will help to contain the number of business failures and support those people who cannot work because of quarantine measures, which will mitigate the hit to national economies. However, this will come at the cost of widening fiscal deficits across Europe.

What are the political implications?

The measures taken to contain the pandemic are not conducive to the normal conduct of democracy. In Germany the party of the chancellor, Angela Merkel, was due to elect a new leader on April 25th at a party congress, but this has been postponed indefinitely. France—controversially—went ahead with nationwide municipal elections on March 15th; the UK has deferred local elections in May until 2021. Parliamentary elections are due to be held in North Macedonia on April 12th and in Serbia on April 26th, but these could be cancelled, as could a series of votes coming up across central and eastern Europe in the following months. A scattering of parliamentary representatives are self-isolating already across the region, and—should outbreaks spread widely among bodies of lawmakers—parliamentary recesses could be enforced, bringing policymaking to a halt.

More broadly, the pandemic may lead to a shift in political preferences in Europe. As people become more averse, politicians who can present themselves as "a safe pair of hands" will benefit. Political and institutional competence will become more attractive, and administrations that are perceived to have mishandled the crisis will come under pressure. In a speech on March 12th Mr Macron, the French president, said that "the virus has no passport", and urged European countries against adopting a nationalistic response. A rejection of international political co-operation or a shift away from globalised economic supply chains could turn this shock into something much more serious.